In conversation with Dhirendra Swarup, Chairman, Pension Fund Regulatory & Development Authority.
From being the Permanent Secretary in the Ministry of Finance, to shaping the budget of the Union Government and easing the transition towards the New Pension Scheme (NPS), Swarup's experience as a civil servant has been nothing short of a challenge.
Against all odds and opposition, he stormed ahead and has been instrumental in the implementation of the NPS.
Take us through the evolution of this New Pension Scheme?
As such the pension story started something like 10 years ago, when the Old Age Social and Income Security (OASIS) Committee was set-up as part of the Ministry of Social Welfare. As of today, 87 per cent or 88 per cent of the work force in our country is outside the social security system. The people who are covered by any pension coverage today, are basically those who are in the organized sector or are government employees.
The magnitude of the problem is such, that the money could not anymore come from the budget, so OASIS Committee's recommendation of Defined Contribution (DC) scheme was considered. This is the genesis of the defined contribution system meant for those in the informal sector.
The Ministry of Finance at the same time was also weighing pros and cons on how to reduce the growing pension liabilities. The growth rate of pension liability of the Centre and State put together is something like 21-22 per cent compounded annually.
So the recommendations by OASIS Committee was given a serious thought to minimize this cost. Then the government thought of switching over to the defined contribution system for all government employee themselves. This they notified in October 2003 and since January 1, 2004 all central government employees have been brought over to the DC system.
The reason for bringing the central government employees first into this system was to grandfather it; otherwise the reforms would not have gone through. Governments in other countries moved everyone into the DC system, but they didn't succeed. The voice of existing employees is such that they can derail or sort of sabotage this kind of plan. So the government rightly decided, at least the new employees should be in DC system. Now to move from Defined Benefit (DB) to DC, only an executive order is required.
Then why was there so much delay in this?
The problem was that there was a law and it said that there will be a regulator; the law also said that the regulator will appoint various intermediaries. Since the law was not in position then the regulator could not appoint the fund manager, Central Recordkeeping Agency (CRA) etc. Therefore, even though the contribution was deducted from the salary of the employee, it was not being invested because there was no fund manager to do so.
Instead this money, which has been collected by the central government as well as 20 other state governments, was being used to finance their own deficits.
So no investment was being made, but the government was paying a fixed return notionally on individual's contribution, that was adding up to the corpus thus increasing its liability only.
I took this up with the government nearly two years ago, that you do not require a law for managing the money. You only require a law for giving me a statutory status as a regulator. But through an executive order you can delegate your own authority to the regulator.
So they authorised me about a year ago to go ahead. Then I went about the mechanism of appointing the CRA - NSDL, fund managers etc. The only thing government told me was, that all the intermediaries should only be from the public sector. NSDL happens to be the best depository under public sector it would not have made difference to me as far regulatory activity is concerned, but it does made a difference in terms of fund managers because there are competent private sector fund managers also. Since the restriction is there I was happy to operate within the restriction, at least there was some movement.
How is the money currently being managed ?
All money invested according to the government guidelines, which is also applicable to the non-government PF, which states that upto 15 per cent, can go into equities and the rest 85 per cent in debt instrument.
What is the magnitude of this money?
At the moment it is only Rs 1,500 crore that has been transferred by the central government. Even though there are 20 state governments that have joined the system, they have not yet transferred fund to the fund managers. But if they do transfer this money, the accumulated amount then will be above Rs 4,000-Rs 4,500 crore as of today.
On monthly basis it will not be a large amount but on an annualized basis it will to the tune of Rs 1,000 crore or so. With the new payscale it could be Rs 1,500 crore or so per annum from now on, for central government alone. And the normal rule of the thumb is that you multiply this by 1.5 times to get to the state governments contribution.
How has the level of reluctance changed in these past few years?
The reluctance on part of states government employees was the real reason for the bill not going through When they were told that no law is required then the opposition started melting down and now the situation is such that the leader of the federation of employee's union has joined my board of trustees.
So we didn't need a new law to change the pension system?
You didn't require a piece of law as such, but you do need reform because there is sea change from DB to DC, on how your contribution will be invested. So a reform was needed but whether it was required through a law or by an executive order was a matter of choice.
But when you are opening it for private sector you require a law for the simple reason to know what will be the course of action, if something goes wrong with the money. Let me assume that the fund manager plays havoc with this money for some reason. I have put a norm say, 85 per cent should be invested in debt and the rest 15 per cent in equity, but he doesn't pay heed and invests 50-50 in both places or do the other way round and invests more in equity. Now how do I penalize in such a case, unless I don't have penal law with me to either impose a fine or suggest imprisonment etc. To enforce this type of regulation a law is required.
What I said was, since there was no law so momentarily I will have a contract with the fund manager. It is an agreement between me and the fund manager, that this is what I expect from you and this is what I will give you in return. Now if you don't follow the terms of the contract set then I will go and use the existing laws of the country like - The Indian Contract Act. with the provisions you know. The only difference being that I cannot impose it directly but will have to go to a normal court of law, so I will be using the judicial system. The government took some time to decide but then agreed to this idea.
What will be the catch for the common people?
That's the challenge. For the people in the unorganized sector this scheme is an option, so no compulsion on the person to come and join the scheme. But the New Pension Scheme (NPS) has a very big drawback, which you might have seen in the newspaper.
In mutual funds, if you hold on to the equity for more than a year then it's free of tax, if you invest in PPF which is not taxed at any stage so you get away by not paying tax at all, same is the case for EPF regarding tax. As you are aware all the three are used as tax savings.
Whereas in case of NPS they brought this under EET (Exempt-Exempt-Tax) regime wherein the first two times (contribution and allocation) are tax free then in the third time there is a tax on the withdrawal. When people will know that there is tax the third time they will not join here, they will probably put there money in PPF or go and buy in mutual funds where they will get higher returns. So it's a very big challenge. Therefore I am fighting these days to get a level playing field.
Do you expect the fund manager to undertake the marketing at any level?
They will have to undertake some sort of marketing, how they will market the product, why the people should go to fund manager “X” and not to fund manager “Y”. Distribution channel wise we are very different from mutual funds and others, the agents mechanism is not there, ultimately agents may mushroom here also and promote the NPS but today they will not because compared to other products ours is very 'unattractive' if that word describes it.
Now having said the disadvantage of the NPS, I will tell you the advantage - first is the cost structure, which will be far lower than what it is in the MF today. Even though the risk is taken with the fund manager, unlike the funds in the MF industry where the clientele and CRA functions is performed by the AMC itself; here we have independent CRA and there are no constituent in the CRA of fund manager etc., at all.
We have very transparent and strict cross-holding CRA restriction, it cannot hold more than 5 per cent of the manager and vice-versa.
So there are no conceptual interests within our intermediaries. Unlike the Mutual Fund model where the board of trustees are appointed by the Asset Management Company, here the regulator shall make the appointment.
The existing framework is that all equity money will be invested as in an index fund. Will this continue?
We probably will have to re-think on it and this is not the final word. We are about to constitute an expert advice group on investment classes.
Will someone be able to make a living out of promoting this system, by convincing people to join it?
Till now we had not needed any such thing because the money was only of government employees, which got transferred directly through the accounts office. But now that the government has announced the scheme it should be thrown open to the private sector as well, I will require someone who can collect the money from the private citizen even in the remotest part of the country.
My two basic criteria to shortlist and register for fee or fund based service are - one that they should be regulated either by RBI or SEBI or IRDA. Second, criterion being they should have electronic connectivity to the CRA so that the money does not keep lying in the pipeline for 10 days or 15 days. These two will be the essential criteria besides normal due diligence about the capital structure, experience and etc., will be there. But all our commercial banks will fulfill these criteria.
What is going to be the incentive for the banks to become your partner?
If they enrol one person they will get to charge some fee, if there is a regular transmission of fund then they get a fee. So to that extent there is encouragement for these banks to promote the NPS that will bring them fee based income.
In fact there is a thought, which is under discussion; it could be both fee based as well as AUM based system; the money we will pay out to the financial institution.
Will this fund be managed by the same amount of transparency with which the MFs are regulated, say for example the regular revelation of the portfolio?
Absolutely, if anything, then we will improve upon that.
Ten crore is hardly any extra liability. Will it not lead to everybody being eligible?
No, but there are other catches also, like the fund manager must be managing Rs 10,000 crore of assets and 10 years of experience. You can't have 'fly-by-night' as an operator who has just opened up a shop couple of years ago and then consider himself eligible. We have given thought to all these so that we get only serious players. Then there is this FDI limit, which law requires so I can't do anything in it which is same as insurance sector. No pension money can be invested overseas, that is another restriction placed by the law.
With all this opening up do you think there is a private party that has potential to become a serious player to this entire scenario?
Yes, I mean there was a survey done by ORG-MARG & AC Nielsen; it was funded by the Asian Development Bank. In this pan-Indian survey, they asked the respondents about their interest in the scheme of such nature describing the features of NPS, and 80 million people responded that they will be interested. The advantage of course unlike the EPF, PPF etc., is that there is seamless possibility in this field, you will be given a permanent retirement account number something like a pan card with your photograph etc., on it. You move across locations, move across jobs and you can log on to the account and deposit in any branch of the bank, any where in the country. So your money goes to the fund manager of your choice.
There is no question of problem in information because the CRA maintains the account. So you can switch from fund manager A to fund manager B, based on one's choice, not too frequent in the beginning, perhaps once a year, maybe later on we will introduce like twice a year. Similarly you can shift from one investment option to another depending on your risk appetite, when you are young you wish to go more into equity and when you get older you lean more towards debt. So its not that you are locked into one fund manager or into one investment option, it's a dynamic thing which we allow. All switches can be done through internet, besides exit, entry or switch load will not be levied. Only thing is that the transaction cost is yours because CRA charges Rs 10 per transaction.
Can you give a time limit as to when this thing will be available to the general public?
The upper time limit is six months. Everything will be available like application form and information kit. Information will be available on all these accounts and plans. Since we have to go through a very transparent process of appointment etc., therefore it takes little time. You have technical evaluation, you have a financial evaluation, and all this takes a little time. So far what we have done is through independent experts, we haven't done it ourselves. All six organizations are independent and do not involve any government appointee. My boards of trustees are all independently chosen, not by government appointment. It is all very transparent.